Macroeconomics: Stocks and Bonds Concepts and Applications Revealed - Research Paper Example

 Macroeconomics: Stocks and Bonds Concepts and Applications Revealed Abstract The objectives of this paper are as follows: (1) it aims to present basis concepts and theories about stocks and bonds by starting with their definitions; (2) the classifications of both instruments would be discussed; and (3) the ways of investing would be explored to inform readers of each option’s considerations in investing funds. Finally, guidelines would be presented on choosing the right option for one’s financial investment. INTRODUCTION The world is beset with a crisis which is financial in nature affecting economies on a global scale. In cases of wide range financial crunch, individuals and corporations are extremely cautious in investing excess funds. From among the most reliable financial instruments that offer returns on investments, stock and bonds provide the most stable of all alternatives. Stocks and bonds are financial instruments utilized by individuals and corporations to invest hard earned money and excess funds. It is in this regard that this essay aims to discuss concepts surrounding stock and bonds. The classifications of each would be presented, as well as distinguishing characteristics. Finally, guidelines would be suggested on the most appropriate option for investing funds – stocks or bonds – given some factors and situations at hand. DEFINITION OF TERMS Stocks are a type of financial instrument that falls under the category of a security. According to a study shown in the Web on Stocks and Bonds, “securities are instruments giving to their legal holders’ rights to money or other property. Securities include stocks, bonds, notes, mortgages”. The InvestorsWorld.com defines stock as “an instrument that signifies an ownership position (called equity) in a corporation, and represents a claim on its proportional share in the corporation's assets and profits. Ownership in the company is determined by the number of shares a person owns divided by the total number of shares outstanding.” (InvestorsWorld.com. Definition of Stock. WebFinance, Inc. Retrieved on March 15, 2009 from. 2009) Bonds, on the other hand, is also a financial instrument exemplifying a certificate of debt issued by either a corporation or a government guaranteeing payment of the original investment with an added interest specified on a future date (Stocks and Bonds. Retrieved on March 15, 2009 ) From the definitions, it can be deduced that stocks and bonds are both financial instruments with the basic difference in ownership. Stocks claim ownership in a corporation represented by shares; while bonds represent debts through issued certificates. Stocks share in the company’s profits through dividends declared. Bonds, on the other hand, receive an interest or a fixed return on investment. Finally, “if a corporation goes bankrupt, bondholders have priority claim, before stockholders, on the company's assets.” (Stocks & Bonds.How to Choose the Right Option. Russell Investments. Retrieved on March 15, 2009 from ) KINDS OF STOCKS Stocks have different classifications depending on dividends declared and on status. Stocks classified depending on dividends declared are either preferred stock or common stock. “Preferred stock is a type of stock in which the stockholder gets a certain percentage of dividends each year based on the profits of the company. Common stockholders get dividends based on the remainder of the profits after preferred stockholders have been paid their dividends.” (Stocks and Bonds. Retrieved on March 15, 2009 from ) Stocks classified according to status of the company relating to potentials of risk and rewards are blue chip stocks or small cap stocks. “Blue chip stocks are issues of companies that are well established within their respective industries and have long histories of producing earnings and paying dividends. Small capitalization, or "small cap," stocks represent shares in companies that are less established. Because of this, they have the potential for tremendous growth, which can translate into a large return for investors. Coupled with this, however, is a higher potential for decrease in their value than you would expect from well-established companies.” (Stocks & Bonds. How to Choose the Right Option. Russell Investments. Retrieved on March 15, 2009 from ) KINDS OF BONDS Bonds are simply classified according to corporate or government bonds. ”U.S. government and U.S. government agency bonds are considered the safest bond investments. They are not insured but are backed by the ‘full faith and credit’ of the U.S. government with respect to both principal and interest. Corporate bonds, on the other hand, are generally issued by industrial corporations, financial firms, public utilities, and transportation companies. They usually pay more interest than government bonds but carry a greater risk of default.” (ibid) WAYS OF INVESTING Stocks are usually obtained in the stock exchange through a stockbroker. A prospective investor calls the stockbroker signifying the investor’s intention to purchase (or sell) shares of stocks. Once purchased, the broker issues and retains a certificate of stock signifying legal ownership of the investor to the shares. The same investor can opt to sell his shares through the same stockbroker. Stock prices go up or down depending on an interplay of market factors such as: profit potentials or actual earnings of the company, the status of the economy, news updates and recent developments. Bonds, when purchased, offer the bondholder a fixed rate as stipulated in the interest rate on the bond. Bonds are issued with an indicated time period and are considered matured and expired when the original investment is returned. SUGGESTED AREA OF FURTHER RESEARCH Given the basis theories needed for investment in either stocks or bonds, it is important to determine the risks and potential returns of each option. In this time of financial crisis, the most viable move an individual or a corporation should consider or delve into for further research are the following areas: (1) The amount of funds to invest. Stocks and bonds have minimum amounts which one can invest in as dictated by the board lot (for stocks) or the principal amount indicated in the certificates (for bonds). (2) The time element for investment. For bonds, there is a stipulated time period for investment indicated in the certificates. For stocks, an investor can either buy or sell at one’s option provided that there has been a substantial return for his investment. (3) The kind of stocks or bonds to invest in. Given the classifications, the prospective investor has to study the companies one wishes to put his hard earned money in to consider factors such as: financial performance of the company in the past years, future prospects, profit potentials, dividends declared, etc. CHOOSING THE RIGHT OPTION A discourse presented by Russell Investments on How to Choose the Right Option gives the guidelines for prospective investors, to wit: ”An important distinction when weighing the rewards of stocks vs. bonds is that stocks have (theoretically) an unlimited ability for appreciation. That is, there is no upper limit to how valuable they can become. On the other hand, a bond buyer generally knows the upper limit to expect on such an investment, especially if it is held to maturity. It is true that a bond can sell at a premium prior to maturity, but the potential for appreciation here is nowhere near as great as it is for stocks. Both options have their risks as well. With stocks, although theoretically there may be no ceiling, there is a bottom. Stocks can drop in value and become worthless. With bonds, there is interest rate, inflation and credit risk. Credit risk is the risk that the bond issuer will be unable to make its payments on time or at all, effectively defaulting on the bonds.” (Stocks & Bonds. How to Choose the Right Option. Russell Investments. Retrieved on March 15, 2009 from ) Return Potential For purposes of illustration, Russell Investments presented a chart indicating the growth of an invested dollar in the stocks listed in the in the S&P 500 Index (stocks) versus $1 invested in the bonds listed in the Lehman Brothers Long Term High Quality Government/Corporate Bond Index and the S&P 500 High Grade Corporate Bond Index (bonds). “While historical performance cannot guarantee future performance, an investment in stocks during this period would have significantly outperformed a bond investment.” (ibid) Growth of a Dollar Source: U.S. Stocks: Standard & Poor's 500 Index. U.S. Bonds: Lehman Brothers Long-Term High-Quality Government/Corporate Bond Index and Standard & Poor's 500 High Grade Corporate Bond Index. CONCLUSION Stocks and bonds are sources of investments which are interesting and exciting to monitor and evaluate. Investments in stocks need close monitoring and constant update with the trends in the market. Stocks could provide very high returns but also the capability to incur substantial losses. Bonds, on the other hand, provide fixed rates which could provide a cushion in one’s investment versus the volatility that a stock investment provides. The best option therefore is to spread one investment among stocks and bonds to maximize yield and minimize risks. Works Cited InvestorsWorld.com. Definition of Stock. WebFinance, Inc. Retrieved on March 16, 2009 from. 2009 STOCKS & BONDS. Retrieved on March 15, 2009 from Stocks & Bonds. How to Choose the Right Option. Russell Investments. http://www.russell.com/us/Education_Center/Learn/Stocks_and_Bonds.asp Read More